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The new GILTI and repatriation taxes: Issues for flowthroughs

Under P.L. 115-97 (the Tax Cuts and Jobs Act, or TCJA), 10%-or-more U.S. shareholders of controlled foreign corporations (CFCs) must include in currently taxable income "global intangible low-taxed income" (GILTI), effective with the CFC's first tax year beginning after Dec. 31, 2017, regardless of whether any amount is distributed to the shareholder.

Although GILTI applies to both corporations and flowthrough entities as CFC U.S. shareholders, only corporations may claim a deduction of 50% of GILTI (37.5% for tax years starting after 2025) and (absent a Sec. 962 election by a noncorporate taxpayer) certain indirect foreign tax credits. Moreover, flowthrough taxpayers are not eligible for the Sec. 245A deduction for qualifying dividends received from CFCs that the TCJA provides for corporations.

The new repatriation tax requires 10% U.S. shareholders of a "deferred foreign income corporation" to increase the foreign corporation's Subpart F income (for the last tax year of the foreign corporation that begins prior to Jan. 1, 2018) in an amount equal to its "accumulated post-1986 deferred foreign income."

Though the repatriation tax is owed for the last tax year of the deferred foreign income corporation beginning before Jan. 1, 2018, taxpayers generally may elect to pay the tax in eight annual installments without interest (with the payment amounts escalating during the last three years).

S corporations, but not partnerships or sole proprietorships, can elect to defer the repatriation tax liability unless a specified triggering event occurs.

In the last several months much has been written about the implications of P.L. 115-97, known as the Tax Cuts and Jobs Act (TCJA).1 For owners of flowthrough entities (including sole proprietorships, partnerships, and S corporations), most of the commentary has focused on the new 20% deduction available for qualified business income (Sec. 199A).2 Of course, the reductions in the corporate and noncorporate tax rates also have received ample attention.3 Collectively, these new provisions raise questions about whether it remains more beneficial to own domestic businesses in a flowthrough structure rather than a corporate structure. In the international context, however, ownership of a foreign corporation by a U.S. flowthrough taxpayer may produce unwelcome results under the TCJA.4

In general, the TCJA shifts the U.S. corporate taxation of foreign earnings to a "quasi-territorial" system, which, for corporate taxpayers, may result in no U.S. tax with respect to income of a controlled foreign corporation (CFC) (even upon repatriation).5 Aspects of the TCJA aimed at transitioning taxpayers to the new system, however, as well as the system itself, treat flowthrough taxpayers that own CFCs considerably differently than corporate shareholders. This article explores two areas of concern for U.S. flowthrough taxpayers that own an interest in one or more CFCs: the new tax imposed on "global intangible low-taxed income" (GILTI) and the new "deemed repatriation" tax imposed on certain previously untaxed income generated by CFCs.6

The new tax on GILTI

Under pre-TCJA law, U.S. shareholders (whether corporations or individuals) that owned 10% or more of the voting stock in a foreign corporation classified as a CFC generally were taxed on the CFC's earnings only upon receipt of a dividend.7 The primary exception historically has been a series of rules generally referred to as the "Subpart F rules," which require the inclusion of certain types of income earned by a CFC on a current basis, regardless of whether a distribution is received.8 Thus, a U.S. taxpayer that structured its operations in a manner that was mindful of the Subpart F rules generally was able to defer U.S. tax on income earned by a CFC until the U.S. taxpayer received a dividend (the amount of which could then be used to fund the payment of the associated U.S. tax liability).

Under the TCJA, Congress has implemented GILTI as a new anti-deferral tax on certain earnings of a CFC, effective starting with the first tax year of the CFC beginning after Dec. 31, 2017.9 Similar to the taxation of Subpart F income, a 10% U.S. shareholder of one or more CFCs will be required to include its GILTI currently as taxable income (in addition to any Subpart F income), regardless of whether any amount is distributed to the U.S. shareholder. The tax on GILTI essentially serves to tax the U.S. shareholder currently on its allocable share of CFC earnings for a tax year to the extent such earnings exceed a 10% return on the shareholder's allocable share of tangible assets held by CFCs. The tax on GILTI applies equally to U.S. shareholders that are corporations or flowthrough taxpayers.

Specifically, a U.S. shareholder's GILTI is calculated as the shareholder's "net CFC tested income" less "net deemed tangible income return" determined for the tax year.10 Net CFC tested income is calculated by determining the U.S. shareholder's pro rata share of tested income or tested loss of each CFC held by the U.S. shareholder, and aggregating those amounts.11 Tested income or loss generally is calculated as a CFC's gross income after excluding items of high-taxed foreign base company income, Subpart F income, related-party dividends, certain foreign oil and gas extraction income, and income of the CFC taxable in the United States as effectively connected income, less deductions allocable to tested income.12 Thus, in the simple case where a single shareholder owns 100% of a CFC with none of the categories of excluded income, net CFC tested income will equal the CFC's net income.

The exclusion for high-taxed income found in Sec. 951A(c)(2)(A)(i)(III) appears to only exclude high-taxed income that is considered foreign base company income (i.e., income of a CFC that potentially gives rise to a Subpart F inclusion). Thus, high-taxed income that is not foreign base company income is included as tested income under the statute. For passthrough taxpayers who do not benefit from foreign tax credits on GILTI (discussed below), this limiting of the exclusion does not make sense — high-taxed potential Subpart F income is excluded, but similarly high-taxed income that is not subject to Subpart F is not. One would expect Sec. 951A to provide an exclusion for income that "would be subject to the high-tax exception if such income were foreign base company income."

Once the net CFC tested income is determined, it is reduced by the shareholder's "net deemed tangible income return" to arrive at the shareholder's GILTI. This amount generally is calculated as the excess of: (1) a U.S. shareholder's allocable share of the U.S. tax basis of depreciable tangible assets used in the production of tested income held by each CFC owned by the U.S. shareholder, multiplied by 10% (subject to certain adjustments); less (2) the amount of interest expense taken into account under Sec. 951A(c)(2)(A)(ii) in determining the shareholder's net CFC tested income for the tax year to the extent the interest income attributable to such expense is not taken into account in determining the shareholder's net CFC tested income.13 For this purpose, Sec. 951A(d)(3) provides that tax basis is determined by applying depreciation on a straight-line basis.14

Where the U.S. shareholder holds multiple CFCs, GILTI is effectively determined on an aggregate basis.

Example 1: As of Dec. 31, 2018, a U.S. shareholder owns 50% of CFC1 and 100% of CFC2. CFC1 has $50,000 of tested income and a tax basis in its tangible assets of $500,000. CFC2 has $80,000 of tested income and a tax basis in its tangible assets of $200,000. The U.S. shareholder will have net CFC tested income of $105,000 (50% × $50,000 + 100% × $80,000). The U.S. shareholder will have a net deemed tangible income return of $45,000 (10% × [50% × $500,000 + $200,000]). The U.S. shareholder's 2018 GILTI will be equal to $60,000 ($105,000 - $45,000).

Once the amount of GILTI has been determined, a U.S. corporate taxpayer may claim a deduction, subject to certain limitations, equivalent to 50% of its GILTI (reduced to 37.5% for tax years starting after 2025).15 Prior to the consideration of U.S. foreign tax credits, this results in a 10.5% minimum tax on a corporate U.S. shareholder's GILTI (50% × 21%). In addition to this "GILTI deduction," a foreign tax credit may be claimed by a corporate taxpayer for 80% of the foreign income taxes paid by a CFC attributable to the shareholder's tested income multiplied by the corporation's inclusion percentage.16 The inclusion percentage is the corporation's GILTI divided by the aggregate amount of the corporation's pro rata share of the tested income of each CFC of which the corporation is a shareholder. Application of the deduction and the tax credit eliminates the U.S. tax owed on the U.S. corporate shareholder's GILTI if the tested income is subject to an effective foreign income tax rate above 13.125%, for tax years before 2026, and 16.406% thereafter.17 From an after-tax cash perspective, the TCJA likely will result in corporate taxpayers' having significantly more cash from foreign operations to deploy in the United States and abroad.

Considerations for flowthrough taxpayers

Though the amount of a U.S. shareholder's GILTI is calculated the same for corporate and flowthrough taxpayers, only corporate taxpayers are entitled to the GILTI deduction and related indirect foreign tax credits. Thus, a flowthrough taxpayer subject to tax on GILTI is taxed on a current basis on the entire amount of its GILTI. Further, because the tax on GILTI arises from foreign business operations, flowthrough taxpayers that would otherwise potentially qualify for the new Sec. 199A deduction cannot include the amount of the GILTI in the base for determining that deduction.18 Accordingly, under most circumstances, noncorporate U.S. taxpayers will pay a current tax on GILTI at a rate up to 37% (the newly enacted highest marginal rate for individuals). A noncorporate taxpayer may make the election under Sec. 962(a) to be taxed as a C corporation and generally obtain the benefits of the lower tax rate applicable to C corporations and associated foreign tax credits (but, likely, not the 50% GILTI deduction). However, making such an election generally requires future distributions of what would otherwise be a return of previously taxed profits to be taxable.19

The effects of the tax on GILTI will vary widely based on the nature of the CFC's business, the number and different tax profiles of the CFCs owned, and the level of capital investment in tangible assets.

Example 2: A U.S. LLC (taxed as a partnership and owned by U.S. individuals) owns a CFC engaged in the business of providing technical services in its foreign country of organization and is taxed in the foreign jurisdiction at an effective rate of 15%. Under pre-TCJA law, the United States generally would tax the CFC's income only when the CFC paid a dividend to the U.S. shareholder. Under the TCJA, however, the U.S. shareholder would be subject to tax currently on the GILTI of the CFC (which, as a services business, conceivably could be virtually all of its net income) at a maximum rate of 37%.

Once the tax on the GILTI is paid, the U.S. tax system generally allows the CFC to distribute an amount equal to the previously taxed GILTI to the U.S. shareholder free of additional U.S. income tax.20 Because cash can be returned tax-free after the tax is paid, the application of the tax on GILTI for a flowthrough taxpayer may be justified as a minimum tax imposed on foreign earnings attributable to nontangible assets. In practice, however, CFCs with operations that give rise to GILTI may have very real restrictions and additional costs associated with distributing cash to pay the tax. These restrictions could include burdensome foreign withholding taxes, local country capital needs that were budgeted based on historic tax rules, or lender-imposed covenants that prohibit distributions.

Noncorporate U.S. taxpayers that own CFCs directly or through a flowthrough entity, or that are considering engaging in new foreign operations, should carefully consider the implications of the new tax on GILTI for their business structures. In certain circumstances, U.S. flowthrough taxpayers will benefit from owning CFCs through a U.S. corporate subsidiary. Under other circumstances, however, it will be advantageous to hold such operations through a foreign flowthrough entity that will not qualify as a CFC, or through a CFC and electing the application of Sec. 962. Clearly, no single approach applies to every existing or planned foreign investment, and prudent taxpayers will need to structure their operations only after taking into account all the relevant factors that will influence their available after-tax cash flow.

The new repatriation tax 'simplified'

Under the TCJA, many corporate U.S. shareholders will no longer be subject to U.S. tax on their CFC earnings because of the 100% dividends-received deduction available for qualifying dividends.21 Accordingly, unless a CFC has Subpart F income or GILTI (that is not ultimately offset by deductions or credits), a corporate U.S. shareholder of a CFC will not pay any U.S. tax on the CFC's earnings, even when distributed. Flowthrough taxpayers are not eligible for the new Sec. 245A dividends-received deduction, and, as the application of the tax on GILTI described above demonstrates, they will be subject to a current tax on their GILTI (without the benefit of the special GILTI deduction or offsetting foreign tax credits). Despite these differences in treatment under the new tax system, a one-time deemed repatriation tax is imposed on both corporate and flowthrough U.S. shareholders of certain foreign corporations. In many instances, the new repatriation tax will produce harsh results for flowthrough taxpayers.

In 2004, Congress enacted Sec. 965 at the urging of several large multinational U.S. taxpayers, thereby permitting a one-time elective repatriation of foreign earnings at a reduced tax rate. The TCJA implements a new one-time repatriation tax by amending Sec. 965 in total, borrowing some of the principles from the former version. The new repatriation tax serves as a mechanism for transitioning the United States to a new territorial-based system for taxing income earned by foreign corporations with material U.S. ownership. Thus, the repatriation tax is mandatory, not elective, and the tax is imposed with respect to deferred foreign earnings without regard to actual distributions. This compulsory repatriation tax has important (and perhaps costly) implications for many U.S. taxpayers.

Mechanically, the new repatriation tax requires 10% U.S. shareholders of a "deferred foreign income corporation" to increase the foreign corporation's Subpart F income (for the last tax year of the foreign corporation that begins prior to Jan. 1, 2018) in an amount equal to its "accumulated post-1986 deferred foreign income."22 This increase results in the U.S. shareholder's including its allocable share of the amount as taxable income under Sec. 951(a)(1)(A). A deferred foreign income corporation is defined as a specified foreign corporation (SFC) that has positive accumulated post-1986 deferred foreign income.23 An SFC is any CFC and any foreign corporation with respect to which one or more domestic corporations is a U.S. shareholder.24

Sec. 965 generally defines accumulated post-1986 deferred foreign income as the earnings and profits of an SFC that (1) have accumulated (i.e., earned and not distributed) after 1986 and while the foreign corporation was an SFC; (2) are not attributable to effectively connected income that was currently taxed by the United States; and (3) are not attributable to income of a CFC that could be distributed as previously taxed income on account of such earnings and profits having been previously taxed at the U.S. shareholder level (e.g., previously taxed Subpart F income).25 The amount of deferred foreign income is measured as of two testing dates, Nov. 2, 2017, or Dec. 31, 2017, with the greater amount taken into account.26 The IRS has provided an alternative method for determining profits as of the Nov. 2, 2017, testing date, in light of the difficulty of making such a determination other than as of the last day of a calendar month.27 Dividends paid during the inclusion year generally are not taken into account as a reduction in the determination of post-1986 earnings and profits, unless the recipient is also an SFC.28

After the U.S. shareholder determines its allocable share of accumulated post-1986 deferred foreign income for each of its deferred foreign income corporations, certain deficits in earnings from other SFCs of the U.S. shareholder (if any), measured as of Nov. 2, 2017, may be used to reduce or eliminate the amount of the required Subpart F inclusion.29 The IRS has released interim guidance indicating that deficits are to be determined taking into account previously taxed income.30 Thus, an SFC with positive cumulative earnings and profits made up of previously taxed earnings and profits and a deficit in nontaxed earnings and profits will not result in an available deficit to offset deferred foreign earnings of other SFCs.31

The U.S. shareholder's allocable share of the increased Subpart F income resulting from the repatriation tax (after reduction for any applicable deficits) is subject to a special deduction designed to lower the effective rate of tax on such "Sec. 965(a) inclusion amount."32 The amount of the deduction is determined at two rates, with the purpose of imposing a higher rate of tax on the amount of deferred earnings related to the U.S. shareholder's "aggregate foreign cash position."

A U.S. shareholder's aggregate foreign cash position is equal to the greater of (1) the aggregate of the U.S. shareholder's pro rata share of the cash positions of all its SFCs as of the last day of the inclusion year (Dec. 31, 2017, for calendar-year SFCs), or (2) the average of the aggregate of the U.S. shareholder's pro rata share of the cash positions of all its SFCs as of the last day of the prior two tax years ending before Nov. 2, 2017.33 For this purpose, "aggregate foreign cash position" means the total of a foreign corporation's (1) cash; (2) net accounts receivable; and (3) the fair market value of actively traded personal property for which there is an established financial market, commercial paper, certificates of deposit, government-issued securities, foreign currency, short-term obligations, and similar assets identified by Treasury as economically equivalent to any of the preceding.34

Once a U.S. shareholder's aggregate foreign cash position is determined, the allowed deduction is the amount that would result in an effective corporate tax rate of 15.5% on the U.S. shareholder's Sec. 965(a) inclusion amount, up to the U.S. shareholder's aggregate foreign cash position. The portion of the Sec. 965(a) inclusion amount that exceeds the U.S. shareholder's aggregate foreign cash position is offset by a deduction that results in an effective corporate tax rate of 8%.35 Where a U.S. shareholder has at least two SFCs with different inclusion years, the statutory rules for measuring the aggregate cash position could result in double-counting of the U.S. shareholder's cash position. The IRS has released guidance addressing this concern, which provides that any cash position taken into account in a prior inclusion year reduces the U.S. shareholder's cash position in the subsequent inclusion year.36

Because in all instances the deduction is calculated based on corporate tax rates, the effective rates imposed on Sec. 965 income for flowthrough taxpayers could be higher.37 After taking into account the deduction, a flowthrough taxpayer taxed at the top individual rate for 2017 inclusions will have an effective tax rate of approximately 17.5% (15.5% × 39.6% ÷ 35%) on its Sec. 965(a) inclusion amount attributable to its aggregate foreign cash position, and an effective tax rate of approximately 9% (8% × 39.6% ÷ 35%) on any Sec. 965(a) inclusion amount above the taxpayer's aggregate foreign cash position.38

As noted above, the tax resulting from the application of Sec. 965 is owed for the last tax year of the deferred foreign income corporation beginning before Jan. 1, 2018 (i.e., the tax year ending Dec. 31, 2017, for calendar-year taxpayers). However, taxpayers generally may elect to pay the resulting tax imposed by Sec. 965 in eight annual installments without interest (with the payment amounts escalating during the last three years).39 The use of the installment method, however, will terminate and the tax obligation will be accelerated in certain circumstances, including the failure to pay any prior installment of the repatriation tax, a liquidation or sale of substantially all the assets of the taxpayer, or a cessation of business by the taxpayer.40

Solely for S corporation shareholders, a deferral election is allowed until the occurrence of a triggering event (including the loss of S corporation status, the sale of substantially all the S corporation's assets, a sale of the S corporation's stock by the taxpayer-shareholder, or the dissolution of the S corporation).41 The conference report accompanying the TCJA fails to provide a rationale for why this special deferral benefit was conferred only on S corporation shareholders and not owners of sole proprietorships or partnerships.42 The following example attempts to provide some clarity to the framework for the imposition of this new repatriation tax.

Example 3: An S corporation (XCo) is owned equally by two U.S. individuals (A and B). A and B pay U.S. tax at the top marginal rate for 2017. For various business reasons, XCo operates in country Y through its wholly owned foreign subsidiary (YCo), which was formed after 1986. A, B, XCo, and YCo are calendar-year taxpayers. A and B do not own a direct or indirect interest in any SFC, other than their indirect interest in YCo. As of Dec. 31, 2017, YCo had post-1986 deferred foreign earnings and profits of $3 million (which exceeded its post-1986 deferred foreign earnings and profits as of Nov. 2, 2017), and XCo had a cash position of $400,000 (which exceeded the average of its cash positions on Dec. 31, 2015, and Dec. 31, 2016).

Analysis: A and B are subject to the repatriation tax, based on their ownership of a U.S. flowthrough entity, XCo, which owns a greater-than-10% interest in an SFC, YCo. The net deferred foreign earnings of YCo are $3 million, resulting in a Sec. 965(a) inclusion amount of $1.5 million for each of A and B. The cash position of YCo is $400,000, resulting in an aggregate cash position of $200,000 for each of A and B. A and B are entitled to a deduction with respect to their allocable share of the deferred foreign earnings attributable to their aggregate cash position equal to $111,429 ($200,000 × (35% -15.5%) ÷ 35%).43 The noncash portion of the deferred foreign earnings for each taxpayer, $1.3 million, is offset by a deduction of $1,002,857 ($1,300,000 × (35% - 8%) ÷ 35%).44 Thus, A and B each will have a tax liability of $152,743 (39.6% × ($1,500,000 - $111,429 - $1,002,857)).

Because XCo is an S corporation, A and B are each eligible to elect to defer the tax liability until the occurrence of a specified triggering event. If either A or B held the interest in YCo directly or through a partnership, the special deferral election would be unavailable to that owner. Absent the special S corporation deferral election, A and B each would be eligible to elect to pay the tax in eight installments, starting with 8% of the liability in 2017 through 2021 ($12,219 each), and increasing to 15%, 20%, and 25% in 2022, 2023, and 2024, respectively.

The Sec. 965 repatriation tax is essentially an immitigable tax.45 Many shareholders of CFCs, and perhaps especially flowthrough taxpayers, may not have become aware of this new tax liability and only belatedly realized that, except for electing S corporation shareholders, the first installment in many instances was due with their 2017 tax bill.

On March 13, 2018, the IRS provided on its website a series of questions and answers (Q&As) on reporting related to Sec. 965 on 2017 tax returns.46 They include the contents of a required statement and manner of making the election provided for in Notice 2018-13, Section 3.02, and other Sec. 965 elections, along with model statements. These include the election to pay net tax under Sec. 965 in installments. The Q&As also cover information reporting to partners and shareholders, the manner of paying the tax on a 2017 return, and other related matters. If a person has already filed a 2017 tax return before reviewing the Q&As, the person may wish to consider filing an amended return attaching prescribed statements and amended versions of necessary forms in accordance with them (see Q&A 12).

In April, the IRS issued a new Publication 5292, How to Calculate Section 965 Amounts and Elections Available to Taxpayers, with a workbook to assist in calculating Sec. 965 amounts and information on various elections.

Though planning generally is not available to reduce or eliminate the tax, U.S. shareholders should consider carefully, and timely make, the appropriate installment or deferral elections to spread the tax liability over the permitted eight-year period, or in the case of a properly situated S corporation, defer the entire tax liability until a triggering event. Additionally, if a commercial transaction is contemplated with respect to a flowthrough taxpayer with an installment or deferral election in place, careful consideration should be given to the acceleration or triggering event implications of such a transaction.

Footnotes

1The TCJA was enacted on Dec. 22, 2017, with most provisions effective for tax years beginning on or after Jan. 1, 2018.

2Sec. 199A generally allows U.S. individuals that earn qualified business income directly or through a flowthrough entity (such as an S corporation or partnership) to deduct up to 20% of their business income in determining their income tax liability. The deduction does not apply equally to all business income, and several limitations may reduce or eliminate a taxpayer's ability to claim the deduction. Germane to this article, the deduction does not apply to income that is not effectively connected with a U.S. trade or business. See Sec. 199A(c)(3)(A)(i).

3The top corporate tax rate was reduced by the TCJA to 21%. The top individual rate was reduced to 37% for 2018 through 2025. See Secs. 1(j) and 11(b).

4References here to "flowthrough taxpayers" are intended to refer to U.S. noncorporate taxpayers owning an interest in a foreign corporation directly or through ownership of an interest in a flowthrough entity (such as a partnership or S corporation).

5The TCJA implements a new 100% dividends-received deduction for U.S. corporate taxpayers that eliminates the tax on dividends received from foreign corporations if certain ownership and holding period requirements are met (seeSec. 245A). No similar deduction is available for noncorporate taxpayers. Additionally, certain deductions and foreign tax credits discussed here often will reduce or eliminate any current taxation relating to the new anti-deferral tax on global intangible low-taxed income (GILTI) (discussed below) for corporate U.S. shareholders of CFCs.

6For U.S. flowthrough taxpayers that engage in foreign activities through a noncorporate form in the local jurisdiction, the TCJA is less transformative. Generally, such taxpayers will continue to be currently taxed on their worldwide income and receive a direct foreign tax credit under Sec. 901 for foreign income taxes paid, subject to applicable limitations.

7A CFC is defined in Sec. 957(a) as a corporation greater than 50% owned by U.S. shareholders, measured by vote or value (after considering applicable rules of attribution). For purposes of calculating ownership, only U.S. shareholders that own 10% or more of the vote or value of the foreign corporation are considered (see Sec. 951(b), as amended by the TCJA, effective Jan. 1, 2018). Prior to the TCJA, the Sec. 951(b) definition referred only to "voting power" and not value. References here to U.S. shareholders (whether with respect to the tax on GILTI or the repatriation tax discussed below) are intended to refer only to U.S. shareholders who hold the requisite 10% interest necessary to be considered a U.S. shareholder within the meaning of Sec. 951(b).

8Subpart F income is defined in Sec. 952 to generally include: (1) insurance income defined in Sec. 953, and (2) foreign base company income. Foreign base company income is defined in Sec. 954 and generally includes foreign personal holding company income (passive income) and certain income earned with the involvement of related parties that includes commercial elements outside the CFC's country of organization. Importantly, a U.S. shareholder also is required to include its pro rata share of income described in Sec. 956, which addresses investments in U.S. property by a CFC. Prior proposed versions of the TCJA would have eliminated Sec. 956 for corporate taxpayers, but the final law retains Sec. 956 for all taxpayers.

11Sec. 951A(c). For this purpose, the U.S. shareholder's pro rata share of a CFC's tested income or loss is determined under the principles for determining a pro rata share of Subpart F income under Sec. 951(a)(2) (see Sec. 951A(e)(1)).

13Secs. 951A(b)(2) and (d). Tax basis is determined at the end of each calendar quarter and then averaged before applying the 10% limitation. The resulting tax basis amount is then further reduced to the extent of any interest expense taken into account in determining the shareholder's net CFC tested income for the tax year to the extent the interest income attributable to such expense is not taken into account in determining the shareholder's net CFC tested income.

14As enacted, the TCJA included two provisions as Sec. 951A(d)(3). The final placement of this provision will depend on the renumbering of Sec. 951A pursuant to a subsequent technical corrections bill.

15Secs. 250(a)(1)(B) and (a)(3). The deduction also includes 50% of the Sec. 78 inclusion associated with the permissible amount of tax credits available to corporate taxpayers in respect of GILTI, as described below.

16Sec. 960(d). A foreign tax credit is permitted for 80% of the corporate taxpayer's GILTI over the taxpayer's tested income, times the aggregate foreign taxes paid that are attributable to tested income.

22Sec. 965(a). With respect to specified foreign corporations (defined below) that are calendar-year taxpayers owned by a calendar-year U.S. shareholder, the inclusion generally is required to be taken into account for the tax year ending Dec. 31, 2017 (though a portion of the tax liability may be subject to payment in later years, as described below).

24See Sec. 965(e)(1). A foreign corporation that is 10% owned by a U.S. corporation and also 10% owned by a flowthrough taxpayer, but not classified as a CFC or passive foreign investment company (PFIC), apparently is treated as an SFC with respect to the flowthrough taxpayer. It is not clear whether this was intended. In all instances, PFICs that are not also CFCs under Sec. 1297(d) are excluded. See Sec. 965(e)(3).

26Sec. 965(d)(3)(A). The IRS has provided guidance to prevent earnings and profits from being double-counted (or excluded) where there are deductible payments between related SFCs between the two measurement dates (see Notice 2018-7, §3.02(a)).

28Sec. 965(d)(3)(B). Where the distribution is to another SFC, Notice 2018-7, §3.02(b), clarifies that the earnings and profits of the payer SFC are reduced only to the extent of the increase in earnings and profits of the payee SFC resulting from the dividend.

29Sec. 965(b). The deficit rules are an important part of the calculation of the Sec. 965 inclusion amount and essentially allow deficits in one SFC to offset positive deferred foreign earnings in another SFC at the shareholder level. It is not entirely clear, however, how the deficit netting rules will apply with respect to flowthrough taxpayers in all instances (e.g., a U.S. individual with a 5% interest in two otherwise unrelated domestic partnerships, where one partnership owns a CFC with deferred foreign income, and the other a CFC with an earnings and profits deficit).

34Sec. 965(c)(3)(B). The IRS has provided temporary guidance that derivative financial instruments and hedging transactions will be treated as cash items in the amount of their fair market value unless they constitute a bona fide hedging transaction (see Notice 2018-7, §3.01(c)). The guidance provides further that the Treasury Department and the IRS are considering whether non-actively traded derivative financial instruments also should be excluded.

37Sec. 965(c)(2) provides that the deduction shall be calculated with respect to the highest rate of tax specified in Sec. 11 (i.e., the income tax rates ­applicable to corporations).

38A Sec. 962(a) election would allow the flowthrough taxpayer to benefit from the corporate tax rate and potential foreign tax credits with respect to the required inclusion, but at the cost of forgoing the treatment of the included earnings and profits as previously taxed income with respect to an actual future distribution (seeSec. 962).

39The amount of the tax, if the installment provisions are elected, is 8% of the total for the first five years and then 15% in the sixth year, 20% in the seventh year, and 25% in the eighth year (seeSec. 965(h)(1)). Payments are due on the due date for the taxpayer's tax return for each year (without extension).

40Sec. 965(h)(3). These triggering events seem to have been drafted primarily with corporate U.S. shareholders in mind, and there may be some confusion on how they apply to flowthrough taxpayers and in the case of internal restructurings (e.g., the incorporation of a partnership through an entity classification election where the partners do not change their level of investment in the underlying business but merely the form).

43The deduction is calculated as: Aggregate cash position tested income × (corporate rate - 15.5%) ÷ corporate rate. This is the amount of deduction required to result in a corporate taxpayer's paying an effective 15.5% rate of tax on the aggregate foreign cash position portion of the Sec. 965(a) inclusion amount.

44The deduction is calculated as: Noncash position tested income × (corporate rate - 8%) ÷ corporate rate. This is the amount of deduction required to result in a corporate taxpayer's paying an effective 8% rate of tax on the noncash position portion of the Sec. 965(a) inclusion amount.

45A fiscal-year SFC (owned by a corporate taxpayer) that anticipates having an amount of cash and cash equivalents as of the end of its fiscal year ending during 2018 in a greater amount than the average of the amount of cash and cash equivalents for the prior two fiscal years may have been able to reduce the effective tax rate on the "deemed repatriation" amount by distributing cash up to the amount of this anticipated excess prior to the end of the fiscal year ending during 2018, because the distribution is eligible for the new 100% dividends-received deduction (due to being made after Dec. 31, 2017). Such a distribution would reduce the aggregate foreign cash position of the corporate taxpayer, resulting in more of the Sec. 965(a) inclusion amount being subject to tax at 8% rather than 15.5%. Such actions likely are forestalled based on the anti-avoidance rules provided by the IRS in Notice 2018-26, §3.04(a).

46IRS, "Questions and Answers About Reporting Related to Section 965 on 2017 Tax Returns," available at www.irs.gov.

Contributor

Todd C. Lady, J.D., is a tax partner with Taft Stettinius & Hollister LLP in Indianapolis and leads the firm’s international tax practice. For more information about this column, contact thetaxadviser@aicpa.org.

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